Sunday, December 5, 2010

The Different Types of Austrian Economics

Although I advocate Post Keynesian economics, I have always been rather intrigued by Austrian economics. In the 1930s, when John Maynard Keynes was establishing the beginnings of the Keynesian revolution, his great intellectual opponent was the Austrian economist Friedrich August von Hayek.

The Austrian school arise in the 1870s as part of the marginalist revolution in economic thought. The founder was Carl Menger, who wrote an influential book called the Principles of Economics in 1871.

LEIJONHUFVUD: In economics, let me come back to a question we have touched upon before. In the twenties in Vienna, was there such a thing as an Austrian school in economics? Did you and your contemporaries perceive an identification with a school?

HAYEK: Yes, yes. Although at the same time [we were] very much aware of the division between not only Meyer and Mises but already [Friedrich von] Wieser and Mises. You see, we were very much aware that there were two traditions—the [Eugen von] Böhm-Bawerk tradition and the Wieser tradition—and Mises was representing the Böhm-Bawerk tradition, and Meyer was representing the Wieser tradition.

LEIJONHUFVUD: And where did the line between the two go? Was there a political or politically ideological line involved?

HAYEK: Very little. Böhm-Bawerk had already been an outright liberal, and Mises even more, while Wieser was slightly tainted with Fabian socialist sympathies. In fact, it was his great pride to have given the scientific foundation for progressive taxation. But otherwise there wasn’t really—I mean, Wieser, of course, would have claimed to be liberal, but he was using it much more in a later sense, not a classical liberal (Nobel Prize-Winning Economist: Friedrich A. von Hayek, pp. 49–50).

The split in the Austrian school in the 1920s was between (1) the classical liberal wing of Eugen von Böhm-Bawerk/Mises (which evolved into modern American libertarianism), and (2) the wing of von Wieser, some of whom were leaning towards Fabian socialism.

However, with the migration of Austrian economics to America and the emergence of Mises as a leading figure, the Classical liberal wing won out, and modern Austrian economics developed from the Classical liberal wing under Mises’ influence.

For much of the 1940s, 1950s and 1960s, Mises, Hayek and Rothbard were the major Austrian thinkers. However, there were a number of other less well known third-generation Austrian economists in this era, including Oskar Morgenstern (1902–1976), Gottfried von Haberler (1900–1995), Fritz Machlup (1902–1983), Paul N. Rosenstein-Rodan (1902–1985), and Friedrich A. Lutz (1901–1975). Not all of them were reflexively hostile to government. Paul N. Rosenstein-Rodan, for instance, was famous for his work on how the state can initiate industrialization in poor nations through planned investment (Rosenstein-Rodan 1943).

In the US, the Austrian tradition was strongly influenced by Mises and Rothbard. Then Austrian economics experienced a resurgence in America from the 1970s onwards:

“American Austrianism revolves around an axis that passes through Auburn University, George Mason University, and New York University. It gets its spin from a 1974 conference held at South Royalton, Vermont, a week-long affair that featured lectures by Murray Rothbard, Israel Kirzner, and Ludwig Lachmann” (Garrison 2001: 259).

One should note that the differences between these types of Austrians are not trivial.

From the 1970s, a new generation of Austrians challenged the older, pure aprioristic methodology of Mises, and advocated a greater role for empirical testing, and Hayek had already moved away from Mises’ methodology with his paper “Economics and Knowledge” (1937).

Personally, I have little time for Austrians of types (1) and (2). The anarcho-capitalists (1) have a radical view that the state must be completely abolished and all of its functions privatized. In the form developed by Rothbard, the case for anarcho-capitalism is based on an untenable and deeply flawed moral argument using natural rights and Aristotelian, neo-Thomist natural law theory (Rothbard 1998). Though my purpose here is not to offer a detailed critique of anarcho-capitalism, one of the most convincing arguments against it is that private protection firms would in fact have an incentive to victimise potential customers to increase market share. Violence of the type that already happens between private mafia groups might occur. A natural monopoly would probably develop as the most powerful firm drove its competitors out of business (or a cartel might become dominant), and one would be left with a de facto state, the very thing anarcho-capitalism sought to abolish! (see Holcombe 2004: 330–331). Moreover, the power relations in an anarcho-capitalist society would appear to be rather like feudalism, with no sense of the common good (Freeman 2001: 147–149). If history is any guide, a movement towards anarcho-capitalism might well result in the kind of incessant violence and warfare between private warlords/protection agencies, as in medieval feudalism. Above all, do we really want to privatise the ownership, use and production of nuclear weapons or biological and chemical weapons? Quite frankly, an anarcho-capitalism system would be one of utter insanity.

The classical liberal Austrians (2) in the tradition of Mises support a minimal state with limited functions, like justice and defence. But Mises’ praxeology is heavily aprioristic, involves an absurd and radical rejection of empirical evidence, and falls apart once one sees the vast number of unsupported subsidiary hypotheses, both present and assumed, that underlie his deductive arguments. Moreover, by admitting the possibility of rational government intervention on utilitarian grounds, Mises’ ideology has a severe logical contradiction (see “Was Mises a Socialist?: Why Mises Refutes Himself on Government Intervention”).

Austrians of type (5) are more interesting. The Austrian radical subjectivists have a “kaleidic” view of economics influenced by the views of the peculiar Austrian–Keynesian hybrid George L. S. Shackle (Lachmann 1976) and stress the subjectivist nature of value, expectations, and knowledge. Lachmann, for example, even denied that free market systems tend to equilibrium or have coordinating processes (Kirzner 2000: 46–47). Lachmann’s radical subjectivism is rejected by Austrians of type (4), who condemned his position as “nihilism” (Kirzner 2000: 47). This rejection is not unreasonable from the perspective of those who support extreme laissez faire economics, because, if there is no neoclassical tendency to full employment equilibrium or Hayek’s plan coordination in a free market system, the alleged economic or moral superiority of such a system collapses. It is thus not surprising that the Lachmann-inspired wing of Austrians aroused some hostility from the moderates who defended the free market as an equilibrating or coordinating mechanism (Dunn 2008: 136).

I am not certain whether Gerald P. O’Driscoll and Mario J. Rizzo are moderate subjectivist Austrians of type (4). Their interesting book The Economics of Time and Ignorance (Oxford, UK, 1985) appears to use Lachmann’s views on the role of time and fundamental uncertainty, but also tries to overcome the charge of “nihilism” by postulating the idea of pattern coordination in place of equilibrium (Gloria-Palermo 1999: 138).

O’Driscoll and Rizzo have made some favourable comments about Post Keynesian economics:

“[i]t is evident that there is much more common ground between post-Keynesian subjectivism and Austrian subjectivism …. the possibilities for mutually advantageous interchange seem significant” (O’Driscoll and Rizzo 1985: 9).

There are indeed some limited similarities in economic analysis between Austrians of type (4) and (5) and the Post Keynesian economists (Böhm 1989: 61).

Paul Davidson, one of leading American Post Keynesians, criticised The Economics of Time and Ignorance in his classic articles “The Economics of Ignorance or Ignorance of Economics?,” Critical Review (1989) 3.3/4: 467–487, and “Austrians and Post Keynesians on Economic Reality: Rejoinder to Critics,” Critical Review 7.2/3 (1993): 423–444. Clearly, there are also very significant differences between Austrians and Post Keynesians.

Austrians of type (4) include Israel Kirzner, who argues that plan/pattern coordination (the Austrian substitute for neoclassical equilibrium) in a free market economy can be achieved by entrepreneurial discovery and creation (Parsons 2003: 7). Type (4) Austrians also include Roger Garrison and others who even engage in “Austrian macroeconomics,” which seems peculiar, given that other Austrians reject the whole concept of macro-theory in economics.

From the perspective of Post Keynesianism, Austrians of type (4) and especially (5) are the most interesting. Ludwig Lachmann, like Keynes, stressed that expectations are subjective, and Lachmann even produced work that has a positive view of aspects of Keynes’ thought. Lachmann’s paper “John Maynard Keynes: A View from an Austrian Window” (South African Journal of Economics 51 (1983): 253–260) argues that

“In the field of methodology Keynes and the Austrians agree that economics is a social science to which methods that have proved successful in the natural sciences should not be applied without careful inspection, …. But Keynes’s mind also moves in another direction. ‘I also want to emphasize strongly the point about economics being a moral science. I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth’ … Keynes sees in social facts manifestations of the human mind. While to Hayek it is the complexity of these facts, their multitude and diversity, that defies the attribution of numerical values to social concepts, to Keynes it is their mental character … that does so. Rather to the surprise of some of us, Keynes emerges as being more deeply committed to subjectivism than is his Austrian opponent (Lachmann 1983: 256).

These similarities have been noted by other scholars too (Caldwell 1989; Parsons 2003: 6).

Though the practical policy recommendations and political outlook of Post Keynesians and Austrians will remain deeply in conflict, there might be something that Post Keynesians can learn from studying the theories of Austrians of type (4) and (5) above.

WALTER BLOCK’S CLASSIFICATION OF AUSTRIAN SUBJECTIVISM

In an article published in 1988, Walter Block proposes a useful division of different types of Austrian subjectivism:

Anarchism is a form of socialism. "Anarcho"-capitalism would be better termed private statism as it simply replaces the state with the power of the landlord/capitalist, who then hires private cops to enforce their rule. It is also self-contradictory:

Oh, I should have mentioned that I agree that Lachmann is the most interesting of the Austrians.

Israel Kirzner, for example, states that the Austrian "approach postulates a tendency for profit opportunities to be discovered and grasped by routine-resisting entrepreneurial market participants", with this "tending to nudge the market in the equilibrative direction." ("Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach", pp. 60-85, Journal of Economic Literature, Vol. 35, No. 1)

It is useful to remember that "postulate" means "to assume without proof to be true" or "to take as self-evident." At its most simple, this argument ignores how entrepreneurial activity pushes an economy away from equilibrium.

Lachmann recognise that market forces have both equilibrating and disequilibrium effects, acknowledged in passing by Kirzner: "In a world of incessant change, they argue, it is precisely those acts of entrepreneurial boldness which must frustrate any discovery efforts made by fellow entrepreneurs."

In other words, market activity can lead to economic crisis and inefficient allocation decisions. A successful entrepreneur will, by their actions, frustrate the plans of others, most obviously those of his competitors but also those who require the goods they used to produce their commodities and those whose incomes are reduced by the new products being available. It staggers belief to think that every action by a firm will be step towards equilibrium or a better co-ordination of plans, particularly if you include unsuccessful entrepreneurs into the process. In other words, the market can be as discoordinating as it can be co-ordinating and it cannot be "postulated" beforehand which will predominate at any given time.

It can be argued that by stressing uncertainty undercuts the Austrian opposition to state intervention. By intervening in the economy, the state can reduce uncertainty -- by bolstering aggregate demand, by taking actions which individual firms would not take due to the uncertainty they face, and so on. Not to mentioning redistributing income so that working class people have more options available, so helping ensure that more people's needs are met than would be the case in a "free" capitalist market.

Uncertainty is an important aspect of Keynes' ideas which are not discussed as much as they should be.

I just wanted to ask the writer of this excellent well-researched blog a question on matters of state-provided and privately provided defence.

You see, today I was at the college library and I found Joseph Stiglitz's Economics of the Public Sector. He had a section on the economics of defense strategy, and he made a very good demonstration of a prime problem of national defence. If it takes 100 missiles to kill 97 terrorists and another 100 missiles to kill the remaining 3 terrorists (diminishing returns), what would be the decision of the government as regards to the higher marginal cost of capturing another terrorist? How would they prevent overproducing missiles and underproducing basic things like a few screening procedures for suspects? The problem is that the government simply does not have the capability of making such a decision, because of the secretive nature of matters of national defence in between various departments alone and the blank cheques handed to the military, especially in US.

Conservatives like Thomas Sowell have argued that even those 3 terrorists alone can cause deaths of many soldiers or civilians, and no limit on defense spending is reasonable. For me, it seems like getting 100 missiles to kill 3 terrorists is akin to paying a billion dollars in insurance to avoid being struck by lightning. Of course, that is the nature of Russian, Chinese, and American defense today.

Now, I may be a pacifist, and I feel the cost-benefit analysis always shows negative results as far as any kind of war or military action goes. But my views will not be considered, and von Mises (who was a bit of a defense hawk and a supporter of pre-emptive strikes) said that pacifists like me will find their pleas falling on deaf ears, and that it's useless to be an appeaser in a warlike world.

Don't you think something like Hoppe's solution has been a step in the right direction - with governments perhaps collecting insurance premia from citizenry and then reinsuring themselves with reinsurance companies?

First time I've seen your blog.Excellent thinking. Clear writing (i'm envious). Mastery of the subject matter.

A thought: As a research program in political economy, anarcho-capitalism has been very fruitful in invalidating traditional assumptions of what institutions are necessary within the classical liberal order. So 'whackiness' aside, it's been useful. Perhaps more useful that solving for unemployment using DSE Models. In fact, that is the proper light to see them in.

Why would private protection agencies not be subject to the same cost-benefit analysis problems you mention as well??

You say:

Don't you think something like Hoppe's solution has been a step in the right direction - with governments perhaps collecting insurance premia from citizenry and then reinsuring themselves with reinsurance companies?

Hoppe advocates abolition of government. I don't under this statement.

Well, it would seem that Hoppe's private protection agencies (a strange idea to begin with, I agree) could have a system of insurance companies that collect premia in return for indemnifying people for actual damage caused from terror attacks, thus making them willing to prevent terror attacks efficiently. For the riskiest terror attacks, they could collect higher premia and thus spend more on preventing them, and for the least riskiest they could collect lower premia and spend less on preventing them. For this reason, private protection will not victimise its own populace for power.

(Although your speculation is not unreasonable - the Italian government came under controversy for "false flag attacks", when it turned out that in the 1970s Italian agents aided and abetted acts of terrorism to win popularity for the government's new defense laws)

I know that Hoppe advocates anarcho-capitalism, but it seems that most of his positions are in at least obtaining action from governments that mirror private players as closely as possible. On immigration, he said that laws restricting immigration are acceptable, because it mirrors what would happen in a private property society. As I understand, he even words it as such that such ideas should "reflect policy", in Democracy: The God That Failed.

Anyway, I am glad you distinguished between different kinds of Austrianism. The Austrian School is too often associated with liberalism, which is too often associated with crank conspiracy theorists like Alex Jones...who are often protectionists! And in the non-American context, it would be associated with the jokers in "Liberal Parties" in Europe that worry more about right to walk naked than about serious economic problems.

The even bigger problem, however, is that the Austrian School is lumped in with "free market economics", let alone the serious differences between various free marketers. As such, everybody incites Adam Smith, and if they criticise Adam Smith, they believe they criticise free market economics, even though Smith was only a smaller part of a larger tradition of economists much before him and beyond him. (And even though other continental Europeans were far advanced of Smith at the same time)

As professors Horwitz & Boettke make clear, Austrian Economics is a set of ideas useful for analyzing and understanding the world; it is NOT a set of policy conclusions:

1. Only individuals choose. 2. The study of the market order is fundamentally about exchange behavior and the institutions within which exchanges take place. 3. The “facts” of the social sciences are what people believe and think. 4. Utility and costs are subjective. 5. The price system economizes on the information that people need to process in making their decisions. 6. Private property in the means of production is a necessary condition for rational economic calculation. 7. The competitive market is a process of entrepreneurial discovery. 8. Money is nonneutral. 9. The capital structure consists of heterogeneous goods that have multispecific uses that must be aligned. 10. Social institutions often are the result of human action, but not of human design.

Appears (to me, anyway) you're using policy conclusions as a basis for categorization which completely misses the point (IMHO).

Moreover, me thinks Menger's formulation of subjective value was an EVOLUTION -- not part of a "Marginalist Revolution" as you claim -- from its primarily German origins. I recommend you read Erich Streissler's paper: "The influence of German economics on the work of Menger and Marshall."

And, if you have already incorporated this paper into your opinion post here, ut believe none the less that it is somehow incorrect, I'd like to hear where exactly Streissler is wrong.

My view is this notion of a "Marginalist Revolution" is a myth created by primarly English writers & then simply regurgitated by mainstream American authors.

For example: how do you account for the subjectivist writings of the Spanish Scholastics which appeared literally hundreds of years before Adam Smith's Wealth of Nations?

Could it be subjective value was "revolutionary" to late 19th Century English speakers only?

Streissler's paper is included in "Carl Menger and his legacy in economics" edited by Bruce Caldwell. It also includes a Streissler paper re: Menger's policy prescriptions from Menger's lectures to Crown Prince Rudolf. Duke University Press published in 1990. Very interesting collection of papers BTW (IMHO) & worth the time investment to read if one's interested in the origins of Austrian Economics.

Well, if Mises praxeology of classical liberal Austrian involves an "absurd" and "radical" rejection of empirical evidence, then indeed it's only right that you "have little time for Austrians of" that type. Then there is vast number of "unsupported" subsidiary hypotheses... well, in reality there are just 2: that there is variety of natural and human resources and that leisure is a consumer good. As we can clearly see, they are "unsupported" (how can you "support" the obvious?), hence Mises sucks. Lastly, Mises Refutes Himself on Government Intervention, because he cannot really predict the future, does government intervention leads to more government intervention or less? That does it for Mises! Let's have little time for this "absurd" and "radical" school!

Lord Keynes, on a purely factual basis, this post has problems. Like:"For much of the 1940s, 1950s and 1960s, Mises, Hayek and Rothbard were the major Austrian thinkers. However, there were a number of other less well known third-generation Austrian economists in this era, including Oskar Morgenstern (1902–1976), Gottfried von Haberler (1900–1995), Fritz Machlup (1902–1983), Paul N. Rosenstein-Rodan (1902–1985), and Friedrich A. Lutz (1901–1975)."

Rothbard was in school in the 40s and hardly one of the most prominent Austrians! And Oskar Morgenstern is one of the founders of game theory!

Also Hayek was not a minimal state advocate. And acknowledging the truths of praxeology hardly commits one to any particular political stance.

I wonder where Larry White falls? The videos I've seen of him, while they support free banking and etc etc he seemed very Hayekian and rational.

The "keynes vs hayek" rap battle video has some links with commentary by him and while I don't believe the school is right, he explained things I've not heard from Austrians before. You of course mentioned Garrison, which at least makes me hopeful a few Austrians are sincere/mean well just misguided. Note: All these "good" Austrians as well as the Cato institute are Hayek derived. The very radical, bitter and dogmatic ones, as well as the Mises institute, all come from Mises I noticed.

So it appears the differences are indeed not trivial. I even came from a semi Austrian belief, though it was on their banking ideas not so much government, which lead to me to Post Keynesianism!

Lord Keynes: "Though my purpose here is not to offer a detailed critique of anarcho-capitalism, one of the most convincing arguments against it is that private protection firms would in fact have an incentive to victimise potential customers to increase market share." - lol sorry this strawman is not persuasive, in fact this scenario described is called 'competition'! Nobody forces a customer to buy, except perhaps in movies at the point of a gun ('offer you can't refuse'). I've lived in countries with the real mafia, and where competition will get you physically hurt (Greece, Philippines) and it's not as bad as an unwarranted audit by the US IRS with the full-enforcement arm of the US government behind it. The former will rarely kill you, but the latter will definitely force you to either go to court (expensive) or pay what they want, and, if you fail to do so, it will make your life more miserable than any mafia don can.